Market Reactions to a High-Quality Auditor and Managerial Preference for Audit Quality

Abstract

SUMMARYWe insert an automated high-quality (HQ) auditor into established experimental audit markets to test the impact of high-quality competition on other auditors' supply of and managers' demand for audit quality. Theory predicts that managers will demand high levels of audit quality to avoid investors' price-protecting behavior. This demand should result in the HQ auditor dominating the market and increase other auditors' audit quality provision to compete with the HQ auditor. However, we find that the HQ auditor does not dominate the market—despite holding audit costs constant and investors placing a premium on HQ auditor reports. We also find that adding an HQ auditor results in other auditors lowering audit quality. Additional analyses indicate some managers demand lower audit quality to avoid negative audit reports, consistent with loss aversion as a potential explanation. Our findings indicate a need to develop a more comprehensive theory of the demand for auditing.Data Availability: The laboratory market data used in this study are available from the authors upon request.